Understanding the point and interest rate tradeoff
Recognizing loan features to avoid
Interviewing lenders and comparing their programs
In Chapter 7
, we explain how to develop a short list of lenders. In this chapter, we get down to the important and often difficult business of comparing various lenders’ loan programs to one another so you can choose the best. As we say throughout this book, “best” doesn’t necessarily mean lowest cost, especially if the lowest cost lender you uncover has lousy service or doesn’t deliver on the glowing promises in its marketing hype.
That said, clearly an important part of your selection process is pricing — namely, the amount each lender charges for a comparable loan. Mortgages require monthly payments to repay the debt. As we discuss in Chapter 1
, your mortgage payment, which is comprised of interest
(lender charges for use of the money you borrowed), and principal
(repayment of the original amount borrowed), is likely your biggest monthly expense of homeownership and perhaps of your entire household budget. Over the life of your mortgage loan, you’ll probably pay more in total interest charges than you originally paid for the home itself.
For example, suppose that you buy a home for $200,000. After making a 20 percent down payment of $40,000, you get a $160,000 loan. If you borrow that $160,000 with a 30-year fixed-rate mortgage at 7 percent, you end up paying a whopping $223,616 in interest charges over the life of your loan — more than the
purchase price of the home! And those interest charges don’t include various upfront fees, which we discuss later in this chapter (see the section “Other lender fees
”) that most mortgages carry.
However, to keep everything in perspective, rent payments for 30 years could likely total even more than the total cost of buying the home with a mortgage — and after 30 years of renting, you won’t even own the home!
Taking a Look at Loan Fees
By far, the biggest expense of a mortgage is the ongoing interest charges — normally quoted as a percentage per year of the amount borrowed. You may be familiar with rates of interest if you’ve ever borrowed money through student loans, credit cards, or auto loans. In these cases, lenders may have charged you 9, 10, 12, or perhaps even 21 percent interest or more for the privilege of using their money. (Now you know how banks pay for their downtown corporate headquarters and the marble in their branch lobbies!) Similarly, mortgage lenders also quote you an annual interest rate on mortgage loans.
However, in addition to paying interest on your mortgage loan on an ongoing basis, most mortgages charge an upfront fee known as basis points
or a loan origination fee.
This section also zeros in on other lender charges such as application and processing fees as well as fees you may incur for a credit report and property appraisal.
The point and interest rate tradeoff
The interest rate on a mortgage is and should always be quoted together with the points on the loan. The points on a mortgage used to purchase a home are tax deductible in the year in which you incur them, whereas on a refinance, the points are gradually tax deductible over the life of the refinanced mortgage loan.
Mortgage lenders and brokers quote points as a percentage of the mortgage amount and require you to pay them at the time that you close on your loan. One point is equal to 1 percent of the amount that you’re borrowing. For example, if lenders say a loan costs one and a half points, they mean that if you take the loan, you must pay the lender upfront 1.5 percent of the loan amount as points. On a $150,000 loan, for example, one and a half points would cost you $2,250.
Because no one enjoys paying extra costs such as these, you may rightfully be thinking that as you shop for a mortgage, you’ll simply shun those loans that have
high points. Don’t get suckered into believing that no-point loans are a good deal. You’ll find no free lunches in the real estate world. Unfortunately, if you shop for a low- or no-point mortgage, you’re going to pay other ways. The relationship between the interest rate on a mortgage and that same loan’s points can best be thought of as a seesaw; one end of the seesaw is the loan’s interest rate, and the other end of the seesaw represents the loan’s points.
So if you pay less in points, the ongoing interest rate will be higher. If a loan has zero points, it must have a higher interest rate than a comparable mortgage with competitively priced points. This fact doesn’t necessarily mean that the loan is better or worse than comparable loans from other lenders. However, in our experience, lenders that aggressively push no-point loans may not be the most competitive on pricing. Lenders can price and present a prospective loan to you in many different ways, but never forget that, one way or another, lenders will make sure they cover all their costs. You need to ask a lot of questions to make sure you understand how lenders are charging you for borrowing their money so you can determine the best loan for your needs.
There are technically two types of points — origination Points
and discount points
— but they both are just points. Don’t let a lender confuse the situation with those terms. Any points paid should get you something — namely a lower ongoing interest rate.
You may be surprised to hear us say that some people may be better off selecting a mortgage with higher points. If you pay higher points on a mortgage, the lender should lower the ongoing interest rate. This reduction may be beneficial to you if you have the cash to pay more points and want to lower the interest rate that you’ll be paying month after month and year after year. If you expect to hold onto the home and mortgage for many years, the lower the interest rate, the better.
Conversely, if you want to (or need to) pay fewer points (perhaps because you’re cash constrained when you take out your loan), you can elect to pay a higher ongoing interest rate. The shorter the time that you expect to hold onto the mortgage, the more this strategy of paying less now (in points) and more later (in ongoing interest) makes sense.
Take a look at a couple of specific mortgage options to understand the points/interest-rate tradeoff. For example, suppose you want to borrow $150,000. One lender quotes you 7.25 percent on a 30-year fixed-rate loan and charges one point (1 percent). Another lender quotes 7.5 percent (a difference of 0.25 percent) and doesn’t charge any points. Which loan is better? The answer depends mostly on how long you plan to keep the loan.
The 7.25 percent loan costs $1,024 per month compared to $1,050 per month for the 7.5 percent mortgage. You can save $26 per month with the 7.25 percent loan, but you’d have to pay $1,500 in points to get it.
To find out which loan is better for you, divide the cost of the points by the monthly savings
. This result gives you the number of months (in this case, 58) that it will take you to recover the cost of the points. Thus, if you expect to keep the loan for less than 58 months (almost five years), choose the no-points loan. If you plan to keep the loan more than 58 months, pay the points. If you keep the loan for the remaining 25-plus years needed to repay it, you’ll save $7,850 ($26 a month for 302 months).
To make a fair comparison of mortgages from different lenders, have the lenders provide interest rate quotes in writing for loans with the same number of points. For example, ask the mortgage contenders to tell you what their fixed-rate mortgage interest rate would be at one point. Also, make sure that the loans are for the same term — for example, 30 years. This comparison of loans using identical terms will allow you to see whether certain lenders are more competitive than others. Recall that money is a commodity or product just like any other consumer product and that certain money “sellers” (lenders) will be more aggressive with their pricing of their product than others. Your job is to find the lender that offers the product (money) at the lowest price based on your specific needs.
Annual percentage rates
Truth-in-lending law requires lenders to calculate a loan’s Annual Percentage Rate (APR)
when quoting interest rates. In theory, this calculation gives prospective borrowers a way to figure out whether a 30-year fixed-rate loan at 7 percent interest and one point is a better deal than a 6.75 percent mortgage and two points.
APR is a figure that states the total annual cost of a mortgage expressed by the actual
rate of interest paid over the full term of the loan. In addition to the loan’s stated interest rate, the APR also includes prepaid finance charges, such as its loan origination fee and other add-on loan fees and costs. As a result, a mortgage’s APR will always be higher than the interest rate quoted by a lender. The only exception is a no-points, no-fees mortgage, in which case the APR will equal the loan’s quoted interest rate.
APR doesn’t solve all your problems with understanding mortgage rates. For one thing, folks usually don’t keep their fixed-rate loans for the full 15- or 30-year term. As a result, their mortgage’s actual APR will be higher than the quoted APR because its points and loan fees are spread out over fewer years. Calculating the
APR of an adjustable-rate mortgage (ARM) that may or may not adjust monthly, semiannually, or annually based on movement of an index that’s impossible to determine when you get the loan is an exercise in futility.
Our advice is simple: When comparing loans from various lenders, make sure the lenders provide interest rate quotes for loans with the identical points and loan terms. The next section explains a few other common prepaid financing charges.
Other lender fees
After swallowing the fact that you’re paying points on your mortgage, you may think that no other upfront fees will come your way. Unfortunately, you’ll find no shortage of upfront loan-processing charges to investigate when you make mortgage comparisons. Understanding all of a lender’s fees is vital; these fees come out of your pocket. If you don’t understand the fees, you may end up with an unnecessarily high-cost loan or come up short of cash when the time comes to close on your loan. If you’re taking out a new mortgage loan to finance a home purchase, not being able to close could put the kibosh on buying your dream home.
Be sure to ask each lender whose loans you’re seriously considering for a written itemization of all upfront financing charges:
Lender fees:
All lenders have lender fees such as processing fees, underwriting fees, and doc prep fees. These fees can approach or exceed $1,000. These fees all get included (along with any points) into a category called Origination Charges on your upfront Loan Estimate. These fees are charged when the loan closes.
Application fee:
Most lenders don’t charge an upfront application fee, but some do. The application fee may be refundable if the loan is denied. The easiest way to avoid a problem is to avoid lenders that charge upfront application fees (except for the appraisal, which we discuss later in this list).
Credit report:
Your credit report tells a lender how well you manage your finances. Expect to pay $15 to $25 or so (protest significantly higher amounts) for the lender to obtain a current copy of yours. If you know that you have blemishes such as late credit card payments on your report, address those problems before you apply for your mortgage. Otherwise, you’re wasting your time and money by applying for a loan that you’ll be denied. You may obtain a free copy of your credit report from any lender who recently turned you down
for a loan because of derogatory information on your credit file. The lender is legally required to give you a copy of the report. The credit report provider can provide the report as well. If you need to clean up problems on your credit report, see our detailed discourse on the subject in Chapter 2
.
Appraisal:
Mortgage lenders require an independent assessment from an appraiser to determine whether the property that you want to buy is worth the amount you agreed to pay for it. If you’re refinancing, an appraisal is required to ensure that the home is worth more than enough to justify the amount of mortgage money you seek to borrow. The cost of an appraisal varies with the size, complexity, and value of property. Expect to pay $400-plus for the appraisal of a modestly priced, average-type property. You’ll probably have to pay this fee prior to the appraisal.
Lenders generally require an appraisal because if you overpay for your property and home values decline or you end up in financial trouble, experience has shown that some borrowers are likely to walk away from the property and leave the lender holding the bag. That’s how many foreclosures happened in the late 2000s’ real-estate market downturn.
Most appraisals must be paid for upfront. In this case, the appraisal fee is not refundable if the loan is denied or if the appraisal comes in low. If you paid for the appraisal, you are entitled to a copy of the appraisal. If you did not pay for the appraisal upfront, chances are you’re not on the hook for the cost of the appraisal, nor do you have the right to a copy of the appraisal.
To reduce your chances of throwing away money on a mortgage for which you may not qualify, ask the lender whether your application may be turned down for some reason. For example, disclose any potential problems — of which you are aware — on your credit report.
Also, be aware as you shop for mortgages from lender to lender because just as some lenders have no-point mortgages, some lenders also have no-fee
mortgages. If a lender is pitching a no-fee loan, odds are that the lender will charge you more in the ongoing interest rate or points on your loan. If they’re hyping their no-points loan, watch out for the fees and higher interest rates. They’re going to get you one way or another!
So you don’t spend any more than you need to on your mortgage and so you get the mortgage that best meets your needs, the time has come to get on with the task of understanding the available mortgage options.
Avoiding Dangerous Loan Features
Just as with any product or service you may buy, some mortgages come with “features” we think you should avoid. Just as you shouldn’t buy a flimsy umbrella that will break in the first wind and rainstorm or a car model with known defects, what follows are loan bells and whistles you should bypass.
Prepayment penalties
As we discuss in Chapter 4
, a prepayment penalty is a mortgage provision that penalizes you for paying off the loan balance faster than is required by the loan’s payment schedule. Note that some lenders won’t enforce the loan’s prepayment penalties when you pay off a mortgage early because you sold an owner-occupied, one- to four-unit property. Beware of mortgages with so-called hard prepayment penalties
that must be paid without any exceptions.
Prepayment penalties can amount to as much as several percentage points of the amount of the mortgage balance that you pay off early. Although some states place limits on prepayment penalties mortgage lenders may levy on owner-occupied residential property, the charges may still be stiff. For example, on a $150,000 mortgage balance with a 4 percent prepayment penalty, you’ll get socked with a $6,000 surcharge for paying your loan off. A $300,000 mortgage with a similar prepayment penalty would sock you $12,000. (Of course, you may be thinking that you should have such problems as to have such piles of extra cash sitting around in your investment accounts!)
Not as common with residential loans, but many commercial loans even have a “loan lockout” period (typically three to seven years) in which you can’t prepay the loan under any circumstances. This not only prevents you from prepaying the loan but also may severely limit your ability to sell the property unless the new buyer assumes the current loan (which also requires an additional fee and the lender’s approval of the new buyer). Just be sure that you understand each of these loan features and consider various future scenarios that may occur and could hamper your flexibility in selling the property or prepaying the loan.
So how do you discover whether a given mortgage loan comes with a prepayment penalty? As you’re shopping for a mortgage, be sure to ask each lender whether the loan has a prepayment penalty. Also, know that many of the no-point or no-fee mortgages we discuss earlier in this chapter have prepayment penalties. In addition to asking about possible prepayment penalties as you shop for a mortgage, when you think you’ve settled on a loan, carefully review the federal truth-in-lending disclosure and the promissory note (actual loan agreement) to
look for any mentions of prepayment penalties and under what conditions such penalties apply.
Negative amortization
As you make mortgage payments over time, the loan balance you still owe is amortized
(gradually reduced).
The reverse of this process — increasing the size of your mortgage balance — is called negative amortization.
Negative amortization pops up more often on mortgages that lenders consider risky to make. If you’re having trouble finding lenders willing to offer you a mortgage, be especially careful.
Negative amortization is what happens, for example, when you pay only the minimum payment required on a credit card bill. You continue accumulating additional interest on the balance as long as you make only the minimum monthly payment. However, as we discuss in Chapter 1
, allowing negative amortization to occur with a mortgage defeats the purpose of your borrowing an amount that fits your overall financial goals.
As we discuss in Chapter 5
, some adjustable-rate mortgages (ARMs) cap the increase of your monthly payment but not the increase of the interest rate. Thus, the size of your mortgage payment may not reflect the interest actually due for that payment. So, rather than paying the interest that’s owed and paying off some of your loan balance every month, you may end up paying only a portion of the interest you owe; the extra interest you owe is added to, and thus increases, your outstanding debt. In two words — not good!
Some lenders (and mortgage brokers) aren’t forthcoming about the fact that an ARM they’re pitching you has negative amortization. So how can you avoid negative amortization loans? Start by asking lenders while you’re shopping. Also, as with uncovering prepayment penalties, when you’re getting serious about a loan, review the federal truth-in-lending disclosure and the promissory note the mortgage lender provides you. Be sure to do this well ahead of the loan’s funding date so you have time to negotiate loan charges and fees before it’s too late.
If you don’t understand the legalese in the promissory note, ask for a plain-English explanation. Remember that your loan is likely the single largest purchase you make, so you want to be absolutely sure that you understand all terms and conditions. Don’t
think that you have to approve the new loan so you can learn what’s in it! Take the time upfront to understand the exact terms of the proposed mortgage.
Comparing Lenders’ Programs
Whether you’re in the market to buy a home or you’re seeking to refinance an existing mortgage, you need to get serious about securing a mortgage and initiate the shopping process. (As we discuss in Chapter 2
, we believe that you’ll strengthen your negotiating position with a property seller by taking the time to get preapproved for a mortgage before submitting an offer to buy a home.)
Whether you do the mortgage shopping yourself or hire a competent mortgage broker to assist (see Chapter 7
for details about how to make this important decision), compare a variety of programs to help you assess which is best for you. Lots of facts and figures will be thrown at you, and we’ve found that some simple worksheets can help you keep the details straight and more easily compare various loans.
Fixed-rate mortgages interview worksheet
In Chapter 5
, we walk you through the critical issues to consider when deciding between a fixed-rate mortgage (FRM) versus an adjustable-rate mortgage (ARM). So if you haven’t reviewed that chapter, now is a fine time to do so.
If the security and peace of mind that come with a fixed-rate mortgage appeal to you, you may also be happy to know that shopping for a fixed-rate loan is simpler than shopping for an adjustable-rate mortgage. Simpler, unfortunately, doesn’t translate into easier.
Table 9-1
can help you keep the details of various lenders’ programs clear and make easier comparisons. Taking good notes also ensures that you’ll have documented what you were told if any discrepancies crop up in the future. Here’s a brief description of the elements you need to understand to complete the worksheet in Table 9-1
:
Contact information:
Take the time to jot down the name of the person and the phone number that you call, because you may need to call it again, especially if it’s for a loan that you’re likely to take. Also, some lending institutions are huge. You may end up having your call transferred several times before reaching the final destination. Be sure to ask the person you ultimately interview for her name, direct phone number, fax number, and email address.
Person interviewed:
Your relationship with a lender should be with a specific person, usually the loan officer. This is the person to call if you have more
questions, to check the progress on your loan, to complain if things aren’t moving the way you expected, or to offer thanks when you do get what you were promised or get good service.
Loan processor:
The loan processor handles your loan’s paperwork from the time you submit the loan application until your loan is closed. The loan processor’s job includes everything from conducting the credit investigation to preparing loan documents you’ll sign prior to funding the mortgage. If possible, get the loan processor’s name, direct phone number, fax number, and email address.
Date interviewed:
If discrepancies arise, your notation of dates could prove important.
Program name:
Most mortgage lenders give catchy and sometimes goofy names to various loan types. This jargon helps identify loans.
Interest rate:
What is the annual interest rate the lender is quoting? How long will that interest rate quote be honored? Most interest rate quotes are good for only a limited time or subject to immediate change in times when interest rates are fluctuating (especially if they’re rising).
Points:
As we discuss earlier in this chapter (see the section “The point and interest rate tradeoff
”), an interest rate quote without a quote of points is meaningless. Get the quote for points as well.
Fees:
Although no-fee loans exist, they’re the exception. Therefore, as we highlight earlier in this chapter (see the section “Other lender fees
”), ask the lender to detail any and all fees: application, processing, credit report, appraisal, notary and recording fees, and others.
Required down payment:
For most loans, you’ll be asked for a 10 or 20 percent down payment. So be sure to ask how much down payment is required for the loan terms the lending officer is quoting. Generally speaking, the smaller the required down payment percentage, the greater the risk to the lender of losing money if you default, so the higher the interest rate and/or points you’ll pay.
As we discuss in Chapter 4
, try to make at least a 20 percent cash down payment to avoid paying private mortgage insurance (PMI). The 80-10-10 financing technique we describe in Chapter 6
is another way to eliminate the need for PMI. (Most lenders, rather than thinking in terms of percentage down payments, think instead in terms of loan-to-value ratios — that is, the loan amount divided by the value of the property. For example, a lender may say that it allows an 80 percent loan-to-value ratio: That’s the same as saying that it requires a down payment of 20 percent of the value of the property.)
Loan amount allowed:
All loan programs limit the size of the loans (the amount of money you borrow) that the terms and conditions apply to. What
good is a low interest rate and point quotation if it applies only to loan amounts smaller than you’re seeking? Ask what size loans the terms apply to. Loans that are “conforming,” or below certain secondary mortgage market loan amount limitations, are almost always cheaper than loans that exceed these guidelines.
Term (number of years):
Over how many years will the loan be repaid? Typically, a loan is for 30 years, but some are repaid over 15 years. Under unusual circumstances, other lengths of time may apply. If you need assistance deciding which mortgage period makes the best sense for you, be sure to see Chapter 5
.
Prepayment penalties:
We strongly recommend avoiding loans with prepayment penalties, if there’s any chance you’ll need to sell the property during the first few years of ownership. Tell lenders upfront that you don’t want to consider any loans with these costs or up to what limit you’d consider. For example, a prepayment penalty for up to three years may be acceptable if you have taken a guaranteed three-year job assignment in the area but know that you’ll be moving for your next opportunity. When you discuss individual loan programs, be sure to confirm that the mortgage under consideration doesn’t include prepayment penalties.
Assumability:
This feature allows you to pass on the remaining balance of your mortgage to a creditworthy buyer of your house. Conventional fixed-rate residential loans generally aren’t assumable, but some government loans (FHA, VA) may be assumable. Commercial and multifamily residential property loans, even fixed-rate, often can be negotiated to be assumable at a fee paid by the incoming buyer. For example, upon lender approval of the creditworthiness of the buyer and payment of a 1 to 2 percent fee of the then-current loan balance, the lender will allow the commercial loan to be assumed.
Estimated monthly payment:
How much are you going to pay each month for your mortgage? With an ARM, be sure to know the maximum monthly loan payments that could be in your future. Ask so you’ll have this vital information when you review your expected monthly housing costs (see Chapter 1
).
Owner-occupied requirements:
Lenders have also learned that their risk is lower with residential loans on homes where the borrower is the owner-occupant. If you’ll be living in the property at the time the loan is made, be sure you ask for the owner-occupied loan terms. Non-owner-occupied residential one- to four-unit loans are readily available but typically are quoted higher in interest rates (one-fourth to one-half of a percentage point).
Other issues discussed:
Make note of any other issues of importance you discussed with the lender. Again, your notes may come in handy if any discrepancies arise down the road.
Loan officer name, phone number, fax number, and email address
Loan processor name, phone number, fax number, and email address
Person interviewed
Date interviewed
Program name
Interest rate
Points
Fees
Application & processing
Credit report
Appraisal
Notary & recording
Other
Loan-to-value ratio allowed
Loan amount allowed
Term (number of years)
Prepayment penalties
Assumability
Rate lock terms
Estimated monthly payment
Adjustable-rate mortgages interview worksheet
In Chapter 5
, we discuss the major features and differences among the various adjustable-rate mortgages (ARMs). We also compare ARMs to fixed-rate loans. If you haven’t perused that chapter yet, please do so now.
Few financial products or services are as difficult to shop for as an ARM. We’re not trying to scare you but simply prepare you for the reality of the sometimes-complex issues that confront ARM shoppers.
Table 9-2
is designed to make shopping for an ARM easier on you. Taking good notes of the details of ARMs you’re shopping for serves two purposes. First, you’ll discover more information. Second, your notes will help you hold lenders accountable for their statements and promises. Here’s a brief description of the elements in Table 9-2
:
Contact information:
Make note of the lender’s name and phone number, because you may need to call in the future, especially if it’s for a loan you’re likely to take. Also, some lenders are large, and you may end up having your call transferred before reaching the final destination. Be sure to ask the person you interview for her name, direct line, fax number, and email address.
Person interviewed:
Your relationship with a lender should be with a specific person, usually the loan officer. This may not be the first person you initially speak with, but eventually you want to have a specific person to call if you have more questions, to check the progress on your loan, to complain if things aren’t moving the way you expected or would like, and to thank when you do get what you were promised.
Loan processor:
The loan processor handles your loan’s paperwork from the time you submit your loan application until your loan is closed. The loan processor’s job includes everything from conducting the credit investigation to preparing loan documents you’ll sign prior to funding the mortgage. If possible, get the loan processor’s name, direct phone number, fax number, and email address.
Date interviewed:
If discrepancies arise, your notation of dates could prove important.
Program name:
Most mortgage lenders give catchy and sometimes goofy names to various loan types. This jargon helps identify loans.
Starting interest rate:
ARMs typically start at a relatively low interest rate compared with current fixed-rate loans. So, as we note in Chapter 5
, don’t get seduced by a low-starting, so-called teaser
interest rate.
Index used for future rate determination:
As we discuss in Chapter 5
, an ARM is tied to a particular index, such as the interest rate on treasury bills or certificates of deposit. Knowing and understanding the particular index a lender uses is critical, because some indexes move more rapidly than others. You also need to know the overall trends for interest rates. Are they likely to
rise or fall over the next few years? Combined with your best estimate of how long you’ll own the property, or how many years till you refinance, will have a major impact on your decision about which ARM index will work best for you.
Margin:
The margin is the percentage that a lender adds to the index to determine your ARM’s future interest rate. This is a fixed amount but determines the interest rate you’ll pay. The lower the margin, the better (with all other terms the same). So be sure to ask what the margins are on the ARMs you’re considering. See Chapter 5
for more details on margins.
Periodic interest rate adjustment cap:
Most ARMs adjust every 6 or 12 months. A good ARM, as we discuss in Chapter 5
, limits or caps the amount of the increase (typically to 2 percent per year). In addition to finding out what the adjustment cap is, also inquire about the dollar amount your monthly payment could increase to avoid surprises.
Lifetime interest rate adjustment cap:
A good ARM also caps the maximum interest rate allowed over the life of the loan — typically 5 to 6 percent over the loan’s starting rate. In addition to understanding the highest interest rate allowed on your mortgage, also ask what that means in terms of your potential maximum monthly payment.
Negative amortization:
As we discuss earlier in this chapter (see the section “Negative amortization
”), this situation occurs when your ARM’s monthly loan payment doesn’t cover all the interest you owe on the loan. In other words, your loan payment doesn’t even fully pay the interest that accrued over the last month on the outstanding loan balance. As a result, the loan balance gets bigger each month, which can be financially disastrous for you. We vigorously recommend avoiding loans with this toxic feature.
Points:
As discussed earlier in this chapter (see the section “The point and interest rate tradeoff
”), an interest rate quote without a quote of points is meaningless. Get the quote for points as well.
Fees:
Although no-fee loans exist, they’re the exception. Therefore, as we highlight earlier in this chapter (see the section “Other lender fees
”), ask the lender to detail any and all fees: application, processing, credit report, appraisal, notary and recording fees, and others.
Required down payment:
On most loans, you’ll be asked for a 10 or 20 percent down payment. So be sure to ask how much down payment is required for the loan terms the lending officer is quoting. Generally speaking, the smaller the required down-payment percentage, the higher the interest rate and/or points you’ll pay. As we discuss in Chapter 4
, try to make at least a 20 percent down payment.
Loan amount allowed:
All loan programs limit what size loans the terms and conditions apply to. What good is a competitive interest rate and point quotation if it applies only to loan amounts smaller than what you’re seeking? Always ask what size loans the terms apply to.
Term (number of years):
Over how many years will the loan be repaid? The typical term is 30 years, but some loans are repaid over 15, 20, or 25 years; and under unusual circumstances, other lengths of time may apply. You can literally find a lender these days that will customize your loan to your specific needs. Want a 17-year loan because that’s your time frame for wanting to retire? You can likely find it. If you need assistance thinking through what length mortgage makes the most sense for you, be sure to see Chapter 5
.
Prepayment penalties:
As discussed earlier in this chapter, we implore you to avoid loans with prepayment penalties. Tell lenders upfront that you don’t want to consider loans with such costs, and when discussing individual loan programs, be sure to confirm that the mortgage(s) under discussion don’t include prepayment penalties.
Assumability:
This feature allows you to pass on the remaining balance of your mortgage to a creditworthy buyer of your house if you both desire. Most adjustable-rate loans are assumable. However, because your house will likely have appreciated in value by the time you’re ready to sell, under normal financial conditions future buyers of your property will probably be able to obtain their own financing under better terms than they’d get by assuming your loan. For one, they’re likely to want to borrow more money than the current balance of your loan now. Thus, we don’t think that this is a feature you should go out of your way to find as you shop for an ARM. If a loan is assumable, you may care to ask how the terms of the loan may change and whether there’s a limit on the number of times the loan may be assumed.
Rate lock terms:
You can lock in the rate on an ARM. See the sidebar “A closer look: Rate lock terms
” for a discussion of rate locks.
Estimated monthly payment:
With an ARM, you should inquire both how much you’re going to pay each month initially and after your rate adjusts fully to the index rate for your mortgage, including knowing the absolute maximum payment that could ultimately challenge your budget. You’ll want this important payment information as you review your expected monthly housing costs (see Chapter 1
).
Other issues discussed:
Make note of any other issues of importance you discussed with the lender. Again, your notes may come in handy if any discrepancies arise down the road.
Loan officer name, phone number, fax number, and email address
Loan processor name, phone number, fax number, and email address
Person interviewed
Date interviewed
Program name
Starting interest rate
Index used for future rate determination
Margin
Periodic interest rate cap ___ % every ___ months — monthly payment may increase $ ___ every ___ months
Lifetime interest rate cap ___ %, which would translate into a $ ___ monthly payment
Negative amortization
Points
Fees
Application & processing
Credit report
Appraisal
Notary & recording
Other
Loan-to-value ratio allowed
Loan amount allowed
Term (number of years)
Prepayment penalties
Assumability
Rate lock terms
Estimated monthly payment
Maximum monthly payment
Applying with One or More Lenders
If you do your homework and pick a good lender with a reputation for low rates, quality service, and honesty, applying for one mortgage should be fine.
However, you may be tempted to apply with more than one mortgage lender (or broker). That way, if your first-choice lender doesn’t deliver, you have a backup. Because of the additional time and money involved in applying for more than one mortgage, we recommend that you consider doing so only under the following circumstances:
You have credit problems.
Applying to more than one mortgage lender may make sense if you know you have credit problems that may lead to having your loan application denied. Read Chapters 1
and 2
to whip your finances and credit record into shape before you embark on the home-buying journey.
You’re buying a physically or legally “difficult” property.
It’s impossible, of course, to know in advance all the types of property idiosyncrasies that will upset a particular lender. If you’re buying a home for which you need a mortgage, reduce your chances for unpleasant surprises by asking your real estate agent and property inspector whether any aspects of the property may give a lender cause for concern. This is especially true if the property is a mixed-use property (has residential plus either commercial or retail space components) or one that is no longer consistent with current zoning. Why? If the property is severely damaged or destroyed in a fire or other disaster, the lender is concerned that local officials won’t allow the property to be rebuilt to the same or better condition. If you’re refinancing an existing home, you should know by now whether aspects of your property make getting a mortgage challenging.
If you end up applying for loans with two different lenders, we recommend that you tell both lenders that you’re applying elsewhere and why. If you don’t, when the second lender pulls your credit report, the first lender’s recent inquiry will show up. Don’t be surprised if you have to pay for two appraisals and two sets of credit reports. Lenders generally require their own documentation.
Minimizing your myriad mortgage costs
You may be surprised to hear us say that some people may be better off selecting a mortgage with higher points. If you pay higher points on a mortgage, the lender should lower the ongoing interest rate. This reduction may be beneficial to you if you have the cash to pay more points and want to lower the interest rate that you’ll be paying month after month and year after year. If you expect to hold onto the home and mortgage for many years, the lower the interest rate, the better.
. This result gives you the number of months (in this case, 58) that it will take you to recover the cost of the points. Thus, if you expect to keep the loan for less than 58 months (almost five years), choose the no-points loan. If you plan to keep the loan more than 58 months, pay the points. If you keep the loan for the remaining 25-plus years needed to repay it, you’ll save $7,850 ($26 a month for 302 months).
APR doesn’t solve all your problems with understanding mortgage rates. For one thing, folks usually don’t keep their fixed-rate loans for the full 15- or 30-year term. As a result, their mortgage’s actual APR will be higher than the quoted APR because its points and loan fees are spread out over fewer years. Calculating the
APR of an adjustable-rate mortgage (ARM) that may or may not adjust monthly, semiannually, or annually based on movement of an index that’s impossible to determine when you get the loan is an exercise in futility.
Not as common with residential loans, but many commercial loans even have a “loan lockout” period (typically three to seven years) in which you can’t prepay the loan under any circumstances. This not only prevents you from prepaying the loan but also may severely limit your ability to sell the property unless the new buyer assumes the current loan (which also requires an additional fee and the lender’s approval of the new buyer). Just be sure that you understand each of these loan features and consider various future scenarios that may occur and could hamper your flexibility in selling the property or prepaying the loan.